Developments in household balance sheets in the Netherlands during the second half
of the 1990s share similarities with recent experience in Australia. In the
period from 1995 to 2000, housing credit and house prices rose strongly, reflecting
a combination of low interest rates, financial innovation, an extended period
of strong economic growth and favourable tax treatment for owner-occupier loans.
In 2000, year-ended growth in house prices peaked at more than 20 per cent
and housing credit growth slowed noticeably. Subsequently, the growth rate
in house prices has declined significantly, although prices have not fallen
(Graph B1).

The housing market slowdown was associated with a combination of financial and macroeconomic
developments. Dutch mortgage rates, which are predominantly fixed, rose sharply
from June 1999, reflecting developments in global bond markets and anticipated
monetary policy tightening. In November 1999, the European Central Bank raised
the policy rate by 50 basis points, the first part of a cumulative 225 basis
point tightening (Graph B2).

Weakness in the share market, which gathered pace in 2001, also appears to have weighed
on the housing market. In particular, the popularity of equity-linked mortgage
products is likely to have generated a procyclical influence of equity prices
on the Dutch housing market, encouraging additional borrowing when equity prices
rise and discouraging borrowing when equity prices fall. Surveys commissioned
by De Nederlandsche Bank indicate that equity-linked mortgages accounted for
48 per cent of mortgages taken out in 2001–02, up from 19 per cent in 1991–95.[1]

Tax reform also played a role in dampening the housing market. In particular, the
benefits of mortgage interest deductibility were reduced in 2001 through limits
on the eligibility of deductions and a reduction in marginal income tax rates.

The turnaround in the housing and credit markets was associated with a marked slowing
in the pace of economic activity (Graph B3). GDP
growth slowed across Europe, with several countries, including Germany, falling
into recession. The deceleration was especially pronounced in the Netherlands,
which went from being one of the fastest growing economies in Europe, to one
of the weakest over 2003. The slowing was particularly evident in household
consumption. Over the period from 1995 to 2000, Dutch real consumption grew
at an average annual rate of 4 per cent, underpinned by strong growth in housing
assets, debt and consumer confidence. In contrast, in the following three years,
real consumption fell. The shift is reflected in the household saving ratio,
which after falling by 7½ percentage points between 1995 and 2000, has
subsequently risen by 4½ percentage points.

The large turnaround in GDP and consumption growth can be partly explained by the
dynamics of the house price cycle. Research suggests that housing-secured borrowing
used for purposes such as home improvement and consumption boosted GDP growth
by around 1 percentage point in each of 1999 and 2000, and subtracted around
½ a percentage point from growth in each of 2001 and 2002.[2]

The effect of recent developments is clearly evident on financial institutions. After
growing strongly for a number of years, the revenue of the banking system declined
in 2001 and 2002, partly due to the sharp slowing in credit growth (Table B1). Bad
debt costs also increased over these two years, with total provisioning expenses
in 2002 almost three times that in 2000. Much of the increase, however, was
related to the deterioration in the quality of business loan portfolios, rather
than mortgage portfolios. As economic conditions have improved over the past
year, revenue growth has again picked up and bad debts expense has fallen.
Notwithstanding these fluctuations, Dutch banks have remained highly profitable.